Why I Buy Shares in Penny Stocks

Whenever you tell someone that you are interested in investing in small cap stocks (aka Penny Stocks) 9 times out of 10 you get a look of derision from whomever you are speaking with. Many people immediately think you are bonkers for choosing to put your money into this area of the market and assume that you are on the fast track to the poor house.

In many cases penny stocks are penny stocks for good reasons and the vast majority of them will never amount to anything in the long term. Many people will lose money if they choose to buy penny stocks, but that is because they really don’t know what they are doing and they don’t have a plan of when to enter, when to hold and when to exit a position.

A Quick Stock Market Lesson

There are two main things that people always get wrong when it comes to stocks, which both annoys and frustrates me. So to clear things up I will go into them here:

Let’s talk value – The one with the highest share price is obviously the more valuable one right?

Wrong, in this instance you can’t tell just from the information that I have provided you. Let’s dig a little deeper.

The next thing I want to look at is how many shares each company has on issue.

ILU – 480 million

FMG – 3,113 million

We can now see that FMG has just over 6 times the amount of shares on issue than ILU does. This then impacts on the total market capitalization which we can now look at as we have enough information.

ILU – $4,426 million

FMG – $10,929 million

Now you can easily see which company is more valuable, and it is actually FMG which is about 2.5 times more valuable than ILU, despite it’s share price being 3 times larger. So as you can now see, just because a stock has a low price, it doesn’t mean it is a bad company or worth any less than a stock with a bigger share price. The actual price of the stock has limited value when it comes to your investment decision.

Return on Investment

My next point of contention is in regards to making a profit and so let’s dive right into my example.

Say I have $10,000 in each of the two stocks below:

NEU whose price is $0.05 (Yes, that is 5 cents not $5) which I will have 200,000 shares for my $10,000

TLS whose price is $5.00 ($5 not 5 cents) which I will have 2,000 shares for my $10,000

Now if the share price of both of these stocks increases by 1 cent which one generated the most profit?

You might be surprised to learn that many people think the profit generated on each stock is the same. I have even had heated arguments with people trying to explain the way it actually works. The truth is as follows:

So as you can see, just because they both went up 1 cent, the profit generated is VERY different.

Why I Choose Penny Stocks

The biggest reason why I choose penny stocks is because I can make a far greater returns on my investment in a smaller amount of time. The risk that a company might not make it big in the long term doesn’t both me, because most of the time I am in and out of a stock within a few weeks or whenever I have made my set amount of profit (normally 10-15%).

The biggest trap that most people get caught out with in penny stocks is that they treat them like larger stocks which you can set and forget. Pennys are not like that and they will take your money every time if you aren’t ready to actively manage your portfolio.

Readers

Have you been caught out by penny stocks or do you embrace them and the larger returns like I do?

Interesting view. I have watched some penny stocks for some time, but have yet to pull the trigger. I’ll watch them a bit closer now to get a better feel for them. Thanks for the info.Mr. Bonner recently posted..Driving is more expensive than you might think

Penny Stocks offer very high returns when you get your picks right, but they can also go disastrously wrong. I personally would stay away from penny stocks as they just seem to risky for me and have quite low liquidity. Have you seen Timothy Sykes website? I know that he’s into penny stocks in a big way.Ed recently posted..Saxo Bank anounces launch of Saxo TV

Thank you for this! I have never even taken the time to learn about penny stocks but I love your examples. It looks like when managed right penny stocks can be very profitable.Alexa recently posted..Two of the Most Creative Ways to Save Money

I respect your opinion Glen, but I personally would not touch a penny stock. I have spoken to way too many retail investors who think they’re going to strike it rich with them and they only end up losing their shirts. Here in the States, as Joe said, they’re not traded on an exchange and thus there is very little info on them and many of them are shell corporations. If you can do it then great, but too many people get burned big time by them and lose a lot in the process. All that said, great overview and I think the key in all of this is knowing what you as an investor are investing in.

As an aside, a small cap stock is not necessarily a penny stock…at least here in the States. A stock can be a small cap stock and not be a penny stock, it just means that their market capitalization is lower for variety of reasons and can move to being considered a mid or large cap over tie.John S @ Frugal Rules recently posted..Online Brokerages I’ve Used: Etrade Review

Nice overview. I haven’t ever personally invested in penny stocks, but I do believe there is a time and place for them. Should penny stocks comprise your entire portfolio? No, but they can be a portion of it to help you diversify. You bring up a great point that you can’t treat penny stocks like larger stocks. They need to be actively managed or else you will most likely lose everything.Jake Erickson recently posted..5 Fun and Frugal Summer Activities

I think Penny Stocks and Junk Bonds need to change their names. Much like Welfare, after awhile gets a bad connotation, changed it’s name to SNAP and kind of like toilet paper is now bathroom tissue. Or how about subprime lending is affordable housing? We will now refer to penny stocks as inexpensive investments and junk bonds as high-return lending.

You made some interesting points, Glen. As Joe and John noted, in the States, it is a bit different, so I would not recommend penny stocks to my clients. Unfortunately too many of them are scams. However you’ve obviously had a some good experiences with them, which is fantastic and highlights how things can differ from country to country.Shannon @ The Heavy Purse recently posted..How to Save for Your Child’s College Education

Wow, you really helped teach me a thing or two there. Though, I was all eager, til you warned about ‘set and forget’ which is my share strategy to date. Sigh. It’s so nice to have ‘local’ references too!SarahN recently posted..Waste Wednesday update

I have done some penny stocks here and there. I have made a bit and lost a bit. It really does take a lot of commitment and you have to really set your stops correctly and actively monitor the stock, especially even the smallest news releases.Edgar @ Degrees and Debt recently posted..Giveaway: Everyone Can Enter to Win $500

I don’t have the first idea of where/how to find those and invest. You would also lose $2K if they moved $0.01 down, which is the high risk if you buy too many shares, it would be fun to invest a few hundreds and see where it goes, although a 20% profit on $200 is not very exciting, you can them withdraw the original money and trade for free with more risk.Pauline recently posted..Lessons learned from an investment gone wrong

I agree with your comment that penny stocks should only be a very minimum amount of your overall portfolio. I’ve played around with penny stocks for fun, but they are too risky. It’s kind of like gambling…you can hit it big, but you can also just as easily lose everything you invested.Andrew recently posted..Why I Wouldn’t Want to Win the Lottery

Something I will have to consider investing in. I guess I always thought they were just short of a scam. It is better than going to the local casino.Free Money Minute recently posted..The 51st Employee is Fired!

I didn’t know those. WOW! With just 1% percent increase? Can I really make those money on penny stocks?
Anyways. thanks for sharing those Glen! It can really help me when I began investing on stocks next year.Mark Ross @ Think Rich. Be Free. recently posted..How To Enroll In BPI Online Banking

I have just started trading penny stocks here in australia .I put 500 dollars in each stock and then wait for it too double and then sell,and move onto the next one.I m holding 14 different stocks at present.So far in the last two months gmr and rmx have more than doubled,yrr is almost there.I buy as close to .001 cents as possible.I consider each trade as a share option with unlimited up side and no expiry date.The most I can loose is the 500 if the company goes belly up,and I dont mind sitting and waiting for a move up.I m in odn at .001 cents at present.The have the rights in aussie to a technology that converts plastic to fuel ,i m expecting a good move in this one.I like this style of trading,no need for a stop loss.

That is a really difficult question to answer as it really depends on the stock and how well it holds up when testing support lines.
Normally I try to get in and out of a stock within 3-10 trading days. However if the stock just keeps going up and keeps smashing resistance then I will hold on until it breaks a support line. If I make more than 100% on a stock then I sometimes sell half to recoup my initial investment and then let the rest ride if I think it will continue going up further.

Not with an online broker. You would have to see a full service broker to do that, but they will charge you big fees to use them. I personally would wait until you have at least $500 and then use an online broker like etrade or commsec.

Its all gambling. Super is a involuntary gamble.Good to know the facts. My reason for the post is to say can companies get listed on asx if they are in near backruptcy condition.are their criterias. Hmmm id be more concerned about a company than if it was a penny stock or not.

Great website Glen! Can i ask, is commsec or e-trade the best broker to do penny stock investing? I am planning to buy and hold for no longer than a few days in some instance. Would a minimum of 500 be enough, or should i plan for more considering the fees?

So many questions. Both Commsec and e-trade will work fine, all the big brokers in Australia are pretty much the same honestly.
$500 (excluding brokerage) is the minimum amount you can spend. If you haven’t dabbled in penny stocks before then this is probably a good amount to start with, but be aware that brokerage is about $20 per trade, meaning by the time you buy and sell your penny stock, it will need to have made around 10% just for you to break even. See below

So as you can see, using a small amount of money means that you are losing out through all the fess. If you take the same equation, but make it say $5000 you get a different picture
$5000 + $20 (buy brokerage) + $20 (sell brokerage) = $5040.
$5000 * 10% = $500 (gains)
Profit $5500 – $5040 = $460 (minus capital gains tax).

If you are new to penny stocks though, I certainly would only spend money that you can afford to lose. Starting with 5K might not be wise, but then again $500 means you have less wriggle room in regards to exiting your position in profit.

Here in Canada penny stocks have been good to me…using exactly the strategy you’ve outlined Glen! For us folks who don’t have large sums to play with, penny stocks is a way to make a decent gain even though the actual sum invested is not that huge. Glad to find someone else that has figured this one out!

Hey Glen, I was just wondering what broker you use to trade penny stocks? I’m currently 18 and was thinking on starting with penny stocks as i have read a few books on them and think that i’m ready to try it out. The only problem is i don’t have a lot of money (maybe around 1000-5000) so i don’t really want something with such high fees!

I would like to know how much you rely on the companies value before buying their shares. Do you have a minimum value? Also would you think it is less risky to space out our investment over many companies or place larger amounts over just a couple?

If I am investing for the long term, then the companies value (potential future earnings and share price appreciation VS current price) is pretty much all I look at. If, i’m looking at making quick money, then I base almost all of my decisions off the chart and don’t even check the companies value (except how much debt they have).

It’s always going to be less risky to spread your risk across more investments, however, I would still suggest that having all your money tied up in the one type of investment (in this case – the stock market) is risky.

Please note: This is just me, it doesn’t mean what I do is what you should do.

I have just started to do online trading last month using Commsec and made a couple of good results and I want to start doing penny stocks since it seems like a good one and came to this page by accident on google

I agree that it is best to start off with low so I would like to give it a go for like a few hundred dollars as I can afford to lose, but where do I see or check the list that has penny stocks (Australia ones)? I am happy to do research for every company. I saw one that is like 1c, not sure whether it is worth to go for though

And also I understand that if you use Commsec, it cost $20+$20 (buy and sell fees). Does it also have commission they charge too? Or just the fees Commsec charges?

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